Lease Impairment Testing Under ASC 842: Journal Entries and Expense Impact

Lease impairment testing under ASC 842 follows the two-step model in ASC 360-10-35, the same framework used for property, plant, and equipment. ASC 842 itself does not contain an impairment model; it points lessees to the long-lived asset guidance. You test the right-of-use (ROU) asset as part of an asset group whenever an event or change in circumstances suggests the group’s carrying amount may not be recoverable, compare that carrying amount to undiscounted future cash flows, and if the group fails, write it down to fair value. The resulting loss is permanent, and for operating leases it changes the shape of lease expense going forward.¹

When Impairment Testing Is Required

You are not required to run the test every reporting period. ASC 360-10-35-21 triggers testing only when specific events or changes in circumstances suggest the carrying amount of the asset group may not be recoverable. The standard provides an illustrative list:

A significant drop in the market price of the leased asset or asset group.
A major change in the way the asset is used or in its physical condition, including damage that reduces capacity.
An adverse change in business climate, legal factors, or regulation, such as new rules that restrict use of the leased property or the loss of a major customer.
Accumulated costs for leasehold improvements or build-out that significantly exceed the amount originally expected.
Current-period operating or cash flow losses combined with a history or forecast of continued losses at the location.
A current expectation, at a likelihood greater than 50 percent, that the asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.

The list is illustrative, not exhaustive. A restructuring that relocates operations away from a leased site is a textbook internal indicator even though it isn’t listed. The judgment call is whether the event signals that future cash flows no longer support the carrying amount.

Identify the Asset Group First

You almost never test an ROU asset by itself. ASC 360 requires testing at the asset group level, defined as the lowest level at which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities.² For a leased office or retail location, the ROU asset generally groups with the leasehold improvements, furniture, fixtures, and equipment at that same location because they generate cash flows together.

A retail chain, for instance, groups each store’s ROU asset with the leasehold improvements and equipment at that store. Store-level cash flows drive the test, not chain-wide results. Draw the group too broadly and profitable sites can mask impairment at struggling ones; draw it too narrowly and an asset that supports a profitable operation can look impaired in isolation. Cash flows from one group never offset shortfalls in another.²

Step 1: The Recoverability Test

Compare the asset group’s carrying amount to the sum of the undiscounted future cash flows expected from continued use and eventual disposition of the group.¹ The carrying amount is the unamortized balance of the ROU asset plus any other long-lived assets in the group.

Cash flow estimates should reflect the most probable future outcome. For the ROU asset piece, remaining fixed lease payments are included as cash outflows. If you plan to sublease, estimated sublease income is a cash inflow. Residual value guarantee obligations also flow in.

The word “undiscounted” is doing real work. The test ignores the time value of money, which makes it a relatively low bar. If undiscounted cash flows exceed the carrying amount, the group passes and no loss is recorded. Testing stops. If they fall short, the group fails and you move to Step 2.¹

Step 2: Measure the Loss at Fair Value

The impairment loss equals the amount by which the asset group’s carrying amount exceeds its fair value.¹ Fair value under ASC 820 is the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date.³

Active markets for ROU assets rarely exist, so fair value is typically estimated with a discounted cash flow model. The DCF uses the same cash flow projections from Step 1 but applies a market-participant discount rate that reflects the risks specific to that cash flow stream. Time value of money matters here because the question is what a hypothetical buyer would pay today. The rate should reflect how a market participant would price the risk, not the lessee’s own incremental borrowing rate or weighted average cost of capital. Small changes in the discount rate can swing the loss by hundreds of thousands of dollars, which is where most measurement disputes arise.

Because there is no observable market for the specific right to use a particular leased property, these measurements almost always sit in Level 3 of the ASC 820 fair value hierarchy, driving expanded disclosure requirements about the inputs you used.³

Allocating the Loss Across the Group

When the asset group contains more than one long-lived asset, the Step 2 loss is allocated among them on a pro rata basis using relative carrying amounts. One limit applies: no individual asset can be written below its own fair value. If a pro rata share would push one asset under its fair value, the excess is reallocated across the remaining assets in the group.

Take a group with a $10 million carrying amount that fails recoverability, producing a $2 million Step 2 loss. The group holds four assets, including an ROU asset carried at $3 million with a fair value of $2.5 million. A straight pro rata hit based on the ROU asset’s 30 percent share would be $600,000, but that would drive it below the $2.5 million floor. The ROU asset absorbs only $500,000, and the remaining $100,000 is spread across the other three assets by their adjusted carrying amounts.

No part of the loss is allocated to the lease liability. The lease liability reflects the contractual obligation to pay and is unaffected by impairment. It only changes on a lease modification, remeasurement event, or termination.

The Journal Entry

The entry is straightforward. Debit an impairment loss account (typically presented within operating expenses) and credit the ROU asset to reduce its carrying amount to the post-impairment value. If other assets in the group absorbed part of the loss, each gets its own credit.

The new, lower ROU balance becomes the asset’s revised cost basis. Amortization is recalculated by spreading that new carrying amount over the remaining lease term. The change applies prospectively. Prior periods are not restated.

How Operating Lease Expense Changes After Impairment

This is where practitioners get tripped up. Before impairment, an operating lease produces a single straight-line lease expense each period. After the ROU asset is written down, that straight-line pattern breaks. You continue to accrete interest on the lease liability using the same effective interest method as before, but the impaired ROU asset is now amortized on a straight-line basis over the remaining lease term. Those two components no longer combine to a flat total, so periodic lease cost becomes front-loaded, similar to a finance lease.⁴

The lease keeps its operating classification despite the change in expense pattern. Operating lease presentation and disclosure guidance still applies. Only the expense calculation shifts; the lease is not relabeled, and nothing moves on the face of the balance sheet.⁴

For finance leases, the post-impairment adjustment is less disruptive because the lessee was already recording amortization and interest separately. Recalculate amortization using the new carrying amount over the remaining lease term and move on.

Impairment Is Not Abandonment

Deciding to vacate space does not automatically make the ROU asset impaired. It may instead be abandoned, which is accounted for differently. Abandonment applies when you permanently stop using the underlying property for any business purpose, including storage. If you intend to sublease the space or expect to resume use later, the asset is not abandoned. It may be impaired, but the abandonment model does not apply.

When an asset is abandoned, you shorten the ROU asset’s useful life so the balance reaches zero by the cease-use date. Abandonment is applied at the individual lease component level rather than at the asset group level used for impairment. The lease liability is unaffected either way. You continue recognizing interest on it after vacating the space unless the lease is formally terminated or modified, which catches some companies off guard when they assume walking away ends the accounting obligation.

If you are actively seeking a subtenant, the situation is more likely an impairment than an abandonment, because you still expect to derive economic benefit through sublease income. That projected sublease income enters the Step 1 cash flow estimate and can prevent or reduce the loss.

Presentation, Disclosure, and the No-Reversal Rule

Present the impairment loss within income from continuing operations unless the leased asset relates to a discontinued operation.¹ Show it as a separate line or otherwise distinguish it from routine depreciation and amortization so readers can see its one-time nature.

Footnote disclosures should describe the impaired ROU asset, the circumstances behind the write-down, and the indicators that triggered the test. Disclose the method used to determine fair value and the level in the ASC 820 hierarchy. For the Level 3 measurement that nearly every ROU impairment produces, disclose the key assumptions and inputs in the DCF, including the discount rate and the cash flow projections.³

Once recorded, an impairment loss on a long-lived asset held and used cannot be reversed. If market conditions improve and fair value recovers in a later period, you are prohibited from writing the asset back up. The post-impairment carrying amount is the permanent new cost basis for all future amortization.²

1
Grant Thornton. Applying ASC 360 to Right-of-Use Assets
2
Viewpoint. Impairment of Long-Lived Assets to Be Held and Used
3
SEC.gov. Note 10 – Fair Value Measurements
4
Viewpoint. Impairment – Lessee